Indian and international asset prices may be overvalued, the governor of the Reserve Bank of India told Emerging Markets.
"All round the world most of the central bankers have a feeling the risks are perhaps underpriced, this is a feeling I share," Yaga Venugopal Reddy said in an interview en route to a conference of central bankers in Basle, Switzerland.
Although investors ostensibly recognize the danger, “in the actual operations one is not sure whether the market participants are acting on the basis of this perception," Reddy said.
Reddy’s comments come at a time of unprecedented exuberance for emerging markets. Following a record year in terms of investment and trade flows the voices of pessimists are muted and commercial bankers and investors are spending less time identifying risks than searching out new and more innovative places to park their money.
In general Reddy is certainly not on the pessimistic side: he describes the high growth, low inflation of India as a central banker’s dream. The main risks to the 8 percent-plus growth targeted by Prime Minister Singh’s government are external, stemming from global imbalances and oil prices, he says.
Nevertheless, the governor is keeping an anxious eye on surging domestic real estate prices and stock markets to assess whether prices are exceeded sustainable levels.
Indian credit growth has fluctuated at historically high rates of between 20 and 30 percent in the past two years. While there is evidence of diversification and that much of the money is heading for investments the governor is scrutinizing the data closely.
"There are some pockets where the prices, in particular the asset prices in the housing market and the financial markets, are moving. Therefore one has to be watchful about the way they will evolve," he told Emerging Markets.
Demographic changes, as large swathes of India’s population is attracted to the cities, and widening availability of credit has helped drive up house prices. Massive investment from abroad has had the same affect on share prices.
Despite this and spiraling fuel prices, inflation has remained subdued, a situation the central bank expects to persist.
“Do I expect a hardening of prices next year?” he asked. “Not on the basis of current assumptions."
He wouldn’t rule out adding to January’s quarter point interest rate increase, noting that there is no simple link between inflation and interest rates and that it would be "inappropriate" to draw an inference that, on the basis of current inflation, borrowing costs don’t need to rise.
Rates have increased four times in the past year and a half to reach their current 5.5% level. Where a neutral rate for India lies is as dependent on international as domestic factors, Reddy noted.
For more from Governor Reddy on India’s infrastructure, financial sector and government borrowing see the forthcoming Asia Development Bank issue of Emerging Markets.